In the U.S., many people think being a “millionaire” means you’re wealthy. This post is a guide to becoming a millionaire. It is primarily aimed at young people (high school / college age) in the U.S. If you start at age 20 and make minimum wage, you should be able to be a millionaire.

Patience

You can be rich through crime, luck, or time. Crime is risky; I haven’t any experience in the area so I have no recommendations if you want to go that route. Luck isn’t something you can directly control, although there is the saying Luck favors the prepared. I think there is indeed something to that saying. Keep the big picture in mind, and you are more likely to see opportunities. However what I’m going to focus on here is using time to become rich.

Compounding

The key to having lots of money is compound interest. The second key is to take advantage of government incentives.

Let’s set as a goal I want to be a millionaire when I retire. What will it take to achieve that goal? What it takes depends on your current age. I will start out assuming you are 20 years old. That gives you 47 years before the age of 67, which is considered “full retirement age”. Next, let’s assume laziness. I want to save for 4 years and never save again. This is not an unreasonable goal—when you are young (if you have a job) you will likely be able to save quite a bit, but once you start a family, it will be much harder to save.

Let’s assume I save $X per week (for four years), and I am going to save it for 47 years. I can invest this in index funds in a Roth IRA. The S&P 500 has returned an average of 10.7% per year over the last 70 years, but if I index in Vanguard’s index fund, I have a 0.2% fee, so that comes to 10.5%. If I assume that continues, then I can compute how much I have after 47 years: 1.10547*X*52. Since I am saving over 4 years, and I want to have a million dollars, I need to solve for X: 1.10547*X*52 + 1.10546*X*52 + 1.10545*X*52 + 1.10544*X*52 >= 1000000. When I do that, I find that X is around $51.

Saving $51 per week for 4 years will make me a millionaire.

Caveats

It’s certainly possible (and likely) the stock market won’t behave like it has in the past. Tax laws may change. The government may collapse. The biggest issue is that a million dollars 47 years from now will be worth less due to inflation, and may even be commonplace. Even today, a million dollars isn’t quite enough to retire comfortably.

Still, $51/week doesn’t seem too bad ... to be a millionaire.

Note that you have to put this into an IRA to avoid the capital gains taxes. If you save outside an IRA (or 401(k)), you will lose 1/2 of that in capital gains (2/3rds if you live in California), plus another 1/3rd (estimated) in income taxes. Combined, that means saving in an IRA gives you three times as much as saving outside an IRA (four times as much if you live in California).

Saving works much better when you are young. If you wait until you are 30, you have to save $127/week to get the same effect. If you wait until you are 40, you have to save $344/week.

Perspective

If you have trouble saving, you might think about it this way: if you do nothing (no spending), your $15,000 income (just in one year) will be worth $1,500,000 at retirement. Working a full time job at minimum wage, you’re getting over a million dollars a year added to your retirement. If you buy something worth $50 today (at age 20), it is taking $5,000 out of your retirement. But you have to do something to avoid becoming a millionaire—you have to spend most everything you earn.

Thinking this way, you might think you should never spend anything. Not so. There are a few things to keep in mind:

Once you reach the government limit to IRA contributions ($3,500 I believe), you no longer are saving inside the IRA. The $50 item is not costing $5,000 anymore; it is costing $2,500 ($1,650 in California). Spending money becomes cheaper once you have contributed to your IRA.

As you get older, you get less of a benefit from compounding. The $50 item is taking $5,000 from your retirement when you are 20, but it is taking “only” $2,000 when you are 30; $740 when you are 40. So as you get older, it makes less and less sense to save (assuming you have saved when you are young).

There are other investments you can make when young that are worth more than what you can get from index funds. For example, investing in your health and education and happiness may pay off more than the S&P 500 returns. But be careful with that happiness thing. Make sure that the $50 you spend today on happiness will brign you more happiness than $5,000 will bring later in life. Be careful with the education thing too. Calculate what a four year university is costing you at retirement (add up room&board, tuition, fees, and lost wages). It’s awfully expensive (up to $15,000,000!).

The value of money goes down the more you have. Having ten million dollars isn’t ten times as good as having a million dollars. You need to find balance between spending when you are young and spending when you are old.

When you are young, contribute the max to your IRA or 401(k). It’s not that hard to become a millionaire. It just takes time.

5 comments:

Unfortunately, I didn't know the secret when I was young. I have much catching up to do.

Anonymous
wrote at
Monday, December 20, 2004 at 6:27:00 PM PST

I'm in my mid-30s, and I've found that my salary has increased quickly enough over the years that even though I've saved aggressively since college, recent savings have always far outweighed early savings. I don't expect that growth to continue, but so far it's made my earlier efforts seem much less important than everyone made them out to be.